Challenges of The Iraqi Kurdistan’s Oil Sector

7 months agoPolicy Reports

Introduction
In
the mid-2000s, the Kurdistan Regional Government (KRG), with the support of international
oil companies, began investing in oil and gas infrastructure. In a relatively
short period, it succeeded in both exporting its oil to international markets
and using its produced gas to supply local power plants. However, the KRG failed
to establish a successful economic policy to manage its natural resources. Such
governance would have ensured managed growth and supported its oil and gas
sector. Instead, the KRG’s oil and gas project became a root cause of a
constitutional dispute with the Federal Government of Iraq (FGI) that resulted
in political and economic damage to the region. Regardless of its lost
opportunities, the KRG can still use the Kurdistan’s natural gas reserves to
regrow its collapsed economy and achieve political stability. However, this is
dependent on its willingness to implement structural economic reforms.

The Hopes and Big Mistakes Underpinned KRG’s Energy SectorKurdish
officials were expecting their energy sector attract global and regional
powers’ support to their historical Kurdish dream and cause. Initially, a
significant number of multinational oil companies, such as ExxonMobil, GASPROM,
Genal Energy and Total Global flocked to the region. While the KRG succeeded in
attracting these companies, it failed to achieve political and economic
overtures from Iraq and the international community. Instead, the region became
subject to a retraction of its political relationship with FGI, regional powers
and the international community. As a result, its economy faced significant
damage.
Many
Kurdish leaders saw the development of the Kurdistan Region of Iraq (KRI)’s oil
sector as a significant political achievement. In this regard, in the region’s general
election of 2013, the Kurdistan Democratic Party referenced the regions newly
established oil pipelines as s symbol of economic growth and political success.
This optimism was so confident and widespread across the Kurdistan Region that
in 2013 all of the Kurdish political parties voted, without the necessary
economic due diligence, to make Kurdish oil sales independent of the Iraqi
Federal Government. At no point were the FGI’s threats to cut the KRG’s federal
budget share taken seriously by the Kurdish leadership.
The
Kurdish leadership labelled its independent oil sales “an independent economy”.
These Kurdish steps resulted in the Kurds’ selling oil independently of Baghdad,
which cut off the Kurdish share of the Iraqi Federal budget.
In
the first year of independent Kurdish oil sales Kurdistan made an estimated oi-income
$2.3 billion (this estimate does not subtract the money owed to private oil
companies), when their share of the Iraqi Federal budget was 17%; estimated at $7
billion (without subtracting the sovereign expenditures). (1) These estimates
reveal that under these new arrangements the Kurds lost 77% of the amount they
should have received from FGI. This loss of income was the first shock of the KRI’s
new economic model; however, for political reasons, the Kurdish leadership
maintained their pursuit of this new economy. Since 2014, Kurdish oil sales
have never compensated its cut budget from FGI.

Basic Economic TruthsThose
who designed this new oil-based independent economy for the Kurdistan Region
ignored the basic figures of the Iraq’s oil sector. No indicator suggests that Kurdistan
could have been better off selling its oil independently. Contrary, all the
figures show that Kurds will be worse off. The latest data regarding Iraqi and
Kurdish oil exports reveal that in August 2019 the KRG exported 474,000 barrels
per day, 13% of the amount exported by the Iraqi federal government (3.6
million barrels per day). (2) Aside from the low export numbers, Kurdish
profits from oil sales have further reduced as a result of litigation
surrounding the sector, which has presented Kurdish oil as a risky investment.
Furthermore, the cost of extraction, marketing, and export of Kurdish oil is four
times that of Iraqi oil. For example, to export one barrel of oil, FGI pays approximately
$6 (3), while the KRG pays about $ 25 (4) and a further $18 as transit fees to
Turkey and its linked companies. While the average price of the Kurdistan’s oil
was $54 per barrel in the last quarter of 2018, the KRG only received $29 for
each barrel(5). Knowing these simple facts, it is clear to see the extent of
economic damage caused to the Kurdistan Region of Iraq, when Iraq cut the
region’s 17% share national budget share.
All
these problems made the KRI unable to depend on its oil income, and it has kept
depending on FGI’s monthly transfer. Many of the economic issues that currently
face the KRG and the legal lawsuits that have blocked its oil and energy sector
were for the most part expected. Iraq’s federal leaders warned Kurdish
officials about these consequences; however, the Kurdish officials ignored them.

The KRI’s Oil Gamble Until
2009, the most significant issue between Erbil and Baghdad was that of the
Iraqi disputed territories, but when foreign oil companies flocked to Kurdistan
the subject of the disputed territories shifted to a second-priority.
Disagreements and discussions over the management of the natural resources (in
particular oil and gas) became the issue that fuelled the degradation of
relations between the two sides. As a result, the disagreements blocked the
proposed oil and gas legislation from being passed, which in turn prevented the
creation of a legal framework to resolve the issues. Relations between FGI and KRG
continued to deteriorate to the extent that even the fight against a common
enemy (the Islamic State of Iraq and Syria) had little effect in improving
relations.
Also,
the Kurdish energy sector did not have many supporters in the international
community. The events that followed the Kurdish independence referendum in
October 2017 demonstrated how the global powers whose companies were working in
the Kurdish energy sector (such as the United States, Turkey, the European
Union, China and Russia) ultimately supported a united Iraq. They chose to
remain silent on the Iraqi federal government and the Iraqi Popular
Mobilisation Forces’ assault on the Kurdish held Iraqi disputed territories.
This event alone and the subsequent loss of Kirkuk’s oil fields reduced Kurdish
daily oil exports from 609,000 to
240,000 barrels. (6) This demonstrates that Kurdish oil and natural gas can’t
serve the interests of international powers better than those of the FGI.
The
story of the Kurdish oil and gas sector and its independent economy began when
Turkish companies like Genel Energy and the Turkish Energy Company invested in
the KRI. Further to this, the KRG became entirely dependent on the pipeline that
delivered its oil to the Turkish port of Ceyhan. The day following the
Kurdistan independence referendum of September 2017, Recep Tayib Erdogan, the
Turkish President, on an official visit to a joint military exercise between
Iraq and Turkey on the border with Zaho threatened the KRI saying, “It will be
over when we close the oil taps, all [their] revenues will vanish, and they
will not be able to find food when our trucks stop going to northern Iraq.”
(7)
It
is now clear that most of the political plans and decisions that were taken by
the Kurdish leadership were not well thought out. Instead, the methods worked
to regress the gains in autonomy already made by the Iraqi Kurds since 1991.
The KRG failed to take into considerations the threats and difficulties that
the geopolitics of the region posed to its plans to create an independent
economy. As a result, it was clear that the new Kurdish economy, which Kurdish
officials termed independent, resulted in the opposite. The KRI regressed both
politically and economically when they could have used the opportunity
presented by the Islamic State’s invasion of Iraq to reconcile their
differences with the FGI. If they had taken this step, then the international
community would have supported them.
Moreover,
in 2014, 2015 and 2016, the United States helped to achieve financial and
military agreements between the two sides. However, neither party was
successful in reaching a deal as the political willingness did not exist for a
resolution. Had the government in Erbil been willing to hand over control of
the KRI’s oil in 2014 as it has today, the economic damage it is currently
facing would have been significantly less. Furthermore, the territorial losses
it suffered in October 2017 would not have occurred. Instead, the Iraqi
government may have been willing to make more overtures to the KRG as it was in
a significantly weaker position after losing one-third of its territory to the
Islamic State.

Natural Gas in the Kurdistan Region of Iraq
The
KRG holds three percent of proven global gas reserves, which is estimated at
200 trillion cubic meters. (8) These reserves put the region at the eighth
largest proven reserves in the world after the United Arab Emirates and more
than that which Iraq has (112 trillion cubic meters). (9) If the Kurdish
leadership takes lessons from its mistakes in the management of its oil sector,
its natural gas reserves can be utilised as a new cornerstone for its economy and
gain more political stability by selling its gas to the FGI. Natural gas is one
of the Iraq’s most sought as it is required to resolve Iraq’s electricity
shortages.
The
KRG’s Ministry of Natural Resources (MNR) had plans with Turkey’s Genal Energy
to export its natural gas to Turkey. They planned to increase exports to 20
million cubic meters annually by early 2020. However, this plan was not
implemented due to the events following the 2017 Kurdistan independence
referendum and the war against the Islamic State. Following this, the KRG agreed
with Russian Energy Company ROSNEFT to build a $1 million-gas pipeline to
export the region’s natural gas to Turkey and the European countries. The
proposed pipeline would have the capacity to ship 30 billion cubic meters of
natural gas annually. (10)
While
investors and Kurdish officials want the KRG to export its natural gas to
Turkey and the European Union, some economic experts believe that the best
market for Kurdish natural gas is Iraq itself, not Turkey. By exporting to
Iraq, the KRG can take significant steps towards achieving stability and its
broader political goals. These objectives can form a part of any agreement on
natural gas sales between the FGI and the KRG. If the KRG can broker a win-win
deal, Kurdish natural gas will become a factor of political stability. It will
play a role in reducing tensions between the two sides. However, if the Kurds press
on with only exporting to Turkey and the European Union through the ROSNEFT
pipeline, it is not clear what the KRI can achieve politically. If its previous
oil sales are anything to go by, then challenges for relations between the FGI and
the KRG are clear and worrying.
For
the KRG, Iraq is a closed market and does not come with significant cost to
establish an export infrastructure. Most of the Kurdish natural gas fields in
the region are located around Sulaymaniyah, Chamchamal and Duhok, and they can
be used to fuel the electricity power plants across Iraq. With such a deal, the
KRI would be free from paying significant transit taxes to the Turkish
government and companies. Currently, the KRG pays $6 per barrel to export its
oil through its pipeline with Turkey and also pays taxes and other costs to the
Turkish government. According to Deloitte’s figures, the KRG sells its oil for $29
per barrel in 2017. Based on this ROSNEFT and KAR Company, who owns the Kurdistan
pipeline to Turkey, gain more than 20 percent of what the KRG gains. Moreover,
the taxes and costs paid to the Turkish government are even more. The exact
amount is unclear due to the lack of transparency in the Kurdish oil
sector.
For
Iraq, Kurdish natural gas would be a cheap and easy source of energy.
Currently, the Iraqi government pays $11.23 per cubic meter of Iranian gas. In
comparison, Germany purchases the same amount from Russia for $5.42 and Kuwait
pays $6.49 for the same amount. (11) For Iraq, Iranian natural gas is not only
expensive but comes with a significant headache for the Iraqi federal leaders as
it must break the United States’ sanctions imposed on Iran. To import from
Iran, the Iraqi government must agree to several U.S. conditions, and these
conditions would get renewed every six months.
A
deal between the FGI and the KRG can help Iraq move away from Iranian gas and
replace it with the Kurdistan’s gas. Such a deal would pave the way for a
strategic partnership between the two sides that will serve the interests of
peace and stability on their border and create significant economic advantages
for both parties. If Kurdish natural gas allows for Iraqi city’s like Baghdad
and Najaf to meet their electricity needs, it will not be easy for Baghdad to
take future decisions that would damage the KRG. On the flip side, if the FGI becomes
main buyer of Kurdish natural gas and a significant source of the KRI’s revenue,
it will become difficult for Kurdish leaders to utilise their 20th-century
nationalistic rhetoric to endanger the economic interests. Moreover, given that
both governments are under internal pressures to deliver services for their
people, they have no choice but to put economic cooperation before their
historic personal and ethnic divides.
On
the international level, investment in the natural gas sector is on the
increase as western governments are increasingly focused on delivering greener
energy alternatives. For these government’s natural gas may be a more viable
alternative to oil as it has a 30 percent less pollution rate. (12) Regarding
business and markets, gas prices are more stable than those of oil. Oil is less
stable and fluctuates in line with political, economic and military events.
However, natural gas does not have a standard international price and relies
more on agreements between buyers and sellers. The price takes into account
geographies and the distance that the gas need to be transferred from seller to
buyer. These facts reveal that the Kurdistan’s natural gas reserves can become
a stable and reliable source of income compared to oil.
Without
a doubt, after Iraqi Turkey can be viewed as the second-largest potential
buyer, thereby diversifying its market. Currently, Russian ROSNEFT, which is
one of the leading investors of Kurdish natural gas, wants to export Kurdish
natural gas to Europe via Turkey. Moreover, Turkey is looking to reduce its reliance
on natural gas from Iran, Russian and Azerbaijan. For this, the Kurdistan
Region of Iraq is the closest and most suited source of natural gas for Turkey
as several sources of the region’s natural gas is located in Duhok, on the
border with Turkey. Therefore, Kurdistan can provide natural gas to Turkey and with
significantly reduced costs.

For Oil and Gas, Kurdistan Needs a New Vision and
Economic Policy To
date, the KRG has engaged in an economic model that uses oil revenues to fund
public services. This model places Kurdistan into the bottom of the list of rentier
countries that subject to multiple crises. This rentier economy has proven to
be a significant challenge to other countries elsewhere. For example, Saudi
Arabia, producing more than 10 million barrels of oil per day, is now
attempting to divert its economy away from oil dependency through its Vision
2030 Plan. In Kurdistan and Iraq, both officials and ordinary people are
demanding the diversification of revenue-sources; however, these demands have
yet to be acted on by the respective governments.
The
plan for economic diversification is not a one or two-year policy decision;
instead, it is a process that requires long time period. It needs implementing
at a specific time where the income from oil and gas can support the
introduction of new industries into the economy. Decisions to diversify revenue
sources cannot only be taken as a response to crises to calm discontent and not
be acted on, as happened in the KRI when its government responded to the 2017
economic crash.
Income
from Kurdish oil and gas sales can be utilised to reinvigorate the KRI’s
economy and infrastructure. It can also be used to improve the state of public
services. Instead, what we see is this income is funding a huge payroll with
millions of employees, but one that cannot improve public services. It is for
the KRG to take the final decision on which of these paths it wishes the
Kurdistan to be on. If it continues on its current path, then it should expect
to face continued crises like that of 2017. On the flip side, the KRG can
choose a reform path, like the models currently under implementation by Iran
and Saudi Arabia, to diversify its economy away from oil.
The
majority of literature written on the rentier economic model sees the model in
a negative light, describing it as an “oil curse”. It begins with the
fundamental truth that the nature of income and sources of income that a state
relies on ultimately dictates its political character. If a government relies
solely on the revenue it receives from the sale of natural resources, it will
have no motivation to serve the interests and demands of its citizenry.
Moreover, it makes the public powerless and unable to influence the government
of the day. Hence, the level of democracy and human rights is comparatively
lower in rentier states. If a government and political leaders have enough
wealth at their disposal that they can effectively purchase the hearts and minds
of its people then that government has no motivation to change and will continue
to govern through the distribution of wealth.
For
the KRG, the same is true. If it wants to have better and more fitting
governance, then the rentier model that it currently engages does not serve
this will. It is for this reason that a program of economic reform to move away
from oil and gas must be a primary objective of the KRG. Going forward, the KRG
must provide employment and develop its economy through new economic sectors
such as agriculture, tourism and business. Moreover, any income that it
receives through the sale of its oil and gas should be reinvested in those
sectors. The KRG’s current model is intrinsically weak and cannot continue to
provide for the Kurdistan Region indefinitely. Moreover, it will continue to
make the region unstable, in particular as it is susceptible to economic shocks
and turbulence internationally. Oil and gas is only a curse because it is
mismanaged, if it is managed and reinvested correctly, then oil and gas could
be blessing for the Kurdistan.

Conclusion The
KRI made a significant investment in its oil and gas. It was able to attract
international companies into the KRG’s gas sector. However, numerous economic
and political mismanagement and wrong calculations around the industry brought
the region into a confrontation with the FGI. This confrontation caused
significant damage to the region. Most of the economic and political objectives
behind the attempt to make the Kurdistan’s independent oil sales failed to
materialise; instead, its effort in most cases had the reverse effects.
However, this is not the end of the road as the Kurdistan Region still
maintains the opportunity to take advantage of its economic resources to
develop its economy and achieve political stability.
The
Kurdistan Region’s gas reserves can become a significant source of income for
the region and become a factor for achieving political stability between Erbil
and Baghdad. In effect, the Kurdistan’s natural gas reserves provides the region
with a second chance to reach the objectives it has set itself and failed to
meet previously with its oil sales. To achieve these objectives, Kurdistan must
synchronise economic reforms with the sale of natural gas. It must take the
window of opportunity to diversify its economy away from a renter model. While
Kurdish natural gas reserves are vast and have the potential to provide a
significant income for the Kurdistan Region, if economic reforms are ignored,
then the Kurdistan Region will become subject to the same problems that it has
faced in its recent sale of oil.